For many years, contaminated properties have been considered a current and future liability to their owners (current and future), and to the communities in which they are located. The market value of real property is directly affected by contamination and pollution. Valuation of real property is negatively effected by risks that are not quantifiable in terms of time and/or money. Valuation affects decision making during cleanup of contaminated property, and, likewise, decision making during remediation affects valuation, of the contaminated property and surrounding properties. The result has been that many of these properties are idle and abandoned in spite of their potential value.
"Brownfields" generally includes real properties in a contaminated or stigmatized condition. Brownfields may include, for example, abandoned, idle or under-utilized sites, urban, rural, industrial or nonindustrial real property where development, expansion or redevelopment is complicated by real or perceived contamination. In contrast, "Greenfields" are undeveloped properties located mainly in suburban or rural areas. Fear of contamination is one factor that may steer real estate development to Greenfields, with unintended but nonetheless undesirable consequences such as urban sprawl, habitat destruction or loss of land suitable for agriculture.
Conversely, redevelopment of Brownfields is expected to create economic opportunities through physical improvements, job creation, tax revenues and improved urban planning. Additionally, by redeveloping Brownfields, Greenfields, including, for example, agricultural land, may be preserved and further deterioration of urban cores can be minimized. There is also a substantial unmet need for private investment (e.g., debt, equity and hybrid investments) in Brownfields remediation. This is primarily due to the exposure (or fear of exposure) by investors to environmental liability.
The Environmental Protection Agency's (the "EPA") Environmental Financial Advisory Board (the "EFAB") spend two years researching issues related to financing Brownfields remediation, and issued five reports. The EFAB's core conclusion, set forth in a published letter dated May 31, 1997, from Robert O. Lenna and John C. Wise to EPA Administrator Carol M. Browne, was "wide-scale and long-term success of Brownfields redevelopment must be sustainable in the private sector." However, there continues to be relatively few capital sources for these projects due to the perceived risk. The risk includes:
(1) financial risk, either because the environmental risk is unknown or because it is difficult to measure; and
(2) liability associated with environmental risk, including liability for past effects of contamination (lender liability) and liability of borrowers from noncompliance that could affect their ability to meet financial obligation and the value of the collateral.
There is public acknowledgment and support for the need for private investment in Brownfields remediation. The EPA has now attenuated previous, more burdensome requirements, and has developed risk-based criteria for cleanup to allow the cleanup levels to be based in part on the future use of land, which is directly related to the potential for exposure to contaminants of concern.
In a report dated December 1997, the EFAB stated the following:
In virtually every Brownfields project scenario, the absence of a viable redevelopment project results in the perpetuation of two environmentally undesirable trends: (1) urban decay (environmentally, and further deterioration of existing taxpayer-paid infrastructure, and lack of economic opportunity for nearby residents); and (2) destruction of "Greenfields" to build development that could locate on Brownfields sites. PA1 In our view, those two undesirable trends are not sustainable in the long term as a matter of national environmental or economic policy. We believe that requiring clean-ups to meet appropriately-protective risk-based standards will both: (1) protect the public health and the environment; and (2) help to avoid the perpetuation of those two environmentally undesirable trends.
In addition to risk-based cleanup criteria, public support for Brownfields remediation exists in the Taxpayer Relief Act of 1007. Under this Act, a taxpayer may be able to deduct qualified remediation expenses incurred to clean up properties in several targeted areas. Moreover, taxpayers meeting the requirements of the Taxpayer Relief Act of 1997 are eligible to fully deduct Brownfields cleanup costs in the year in which the costs are incurred, rather than capitalizing and amortizing the costs over several years.
Moreover, certain recent revisions to the Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA) are aimed at protecting passive investors. In particular, CERCLA Section 101(20)(A) contains a secured creditor exemption which eliminates certain liability for lenders who hold indicia of ownership in a Brownfields facility primarily to protect their security interest in that facility, provided they do not participate in management of the facility.
Despite the widespread public acknowledgment of the need for large private investment in Brownfields remediation, and despite the public support for such private investment in the form of rational environmental regulation and tax incentives, there is no useful method or vehicle for large-scale, long-term investment in Brownfields remediation. Conventional private investment in remediation of Brownfields includes only small funds investing on a project-by-project basis, with the quantity of capital available being small in relation to the remediation and development cost of the project financed. Because the remediation costs of individual projects financed is often so large in relation to the type of funds available, the investment risks are large, for financing the cleanup phase, and the cost of capital, therefore, high and the success of the process may be dependent upon the market for the land and development subsequent to clean up, increasing the risk. Moreover, the legal and financing phases are long and expensive. Financial failure of a single project in such a financial model is a disaster for all of the investors. However, if the ultimate development of the property is also considered, the cost of remediation becomes economically feasible in relation to the long-term value.
Moreover, environmental remediation liability, i.e., the legal duties under applicable federal, state and local statutes and regulations regarding environmental liabilities, may attach not only to the owners of the Brownfields, but also to "operators." Operators may include, for example, lenders and others who participate in decision making regarding the Brownfields. Thus, lenders investing in properties needing remediation can themselves become liable for remediation costs if lenders take mortgages to secure their loans. This risk of direct exposure to environmental remediation liability further chills investor interest and increases the cost of privately-financed remediation of Brownfields. Thus, historically, only a small number of investors were able and willing to invest privately in projects involving Brownfields remediation and they expect high returns relative to the risk. This capital cost is another barrier to the feasibility of these projects.
Because of the traditional high risks associated with Brownfields remediation investment, few vehicles exist for such investment. Moreover, few managers have developed expertise sufficient to administer the few such investment vehicles that do exist. There are approximately 5000 registered professional investment advisors for management of a wide variety of investments in stocks, stock portfolios, bonds, and stock and bond funds. There are only a few dozen registered professional real estate investment managers, and only a handful of these managers control the majority of the market (75%). These managers offer very traditional pure equity, first mortgage and participating mortgage products not suited to the this type of investment. However, this investor base is the best source for long term capital.
With few sources of investment capital available for financing Brownfields remediation, Brownfields' owners must often rely on their own financial resources to provide the funds for remediation. These owners include most major industrial corporations, family owned businesses, government entities, farmers, developers and many others. This further constrains resources available to the ongoing business interests of these owners, and therefore, redevelopment is delayed indefinitely.
Moreover, real estate developers typically encounter substantial project delays with attendant costs because there is no single mode of financing that will cover all phases (e.g., acquisition, entitlement, development and construction) of a project. Developers must first arrange financing for acquiring the property and developing plans and designs. The project then typically halts for weeks or months while the developer arranges construction financing. Near the end of the construction phase, the project may be effectively halted again while the developer seeks and arranges permanent financing or sells the project. All three stages of financing are typically provided by separate sources, and financing fees may be required in connection with each stage of financing. Thus, there is a substantial need for a single source of financing to address all stages of a real estate project to lower the cost of capital and facilitate faster completion of a projection. This will also make projects that are not feasible today become feasible including redevelopment of Brownfields.
Furthermore, the three stages of financing are typically carried as full debt on the developer's balance sheet. Carrying environmental project-related debt on the balance sheet reduces the developer's and/or owner's equity, and, therefore, reduces the developer's and/or owner's ability to borrow funds for new projects, expansion, or to support normal operations. Accordingly, there is a need for a method of financing real estate development without reducing a developer's equity or borrowing power ("off balance sheet" financing and/or investment).